Elliott Levin v. William Miller , 763 F.3d 667 ( 2014 )

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In the
United States Court of Appeals
For the Seventh Circuit
____________________
No. 12-‐‑3474
ELLIOTT D. LEVIN, as Trustee in bankruptcy for Irwin Finan-‐‑
cial Corporation,
Plaintiff-‐‑Appellant,
v.
WILLIAM I. MILLER, GREGORY F. EHLINGER, and THOMAS D.
WASHBURN,
Defendants-‐‑Appellees,
and
FEDERAL DEPOSIT INSURANCE CORPORATION,
Intervenor-‐‑Appellee.
____________________
Appeal from the United States District Court for the
Southern District of Indiana, Indianapolis Division.
No. 1:11-‐‑cv-‐‑1264-‐‑SEB-‐‑TAB — Sarah Evans Barker, Judge.
____________________
ARGUED SEPTEMBER 10, 2013 — DECIDED AUGUST 14, 2014
____________________
Before WOOD, Chief Judge, and EASTERBROOK and
HAMILTON, Circuit Judges.
EASTERBROOK, Circuit Judge. Irwin Financial Corporation,
a holding company, entered bankruptcy when its subsidiar-‐‑
2 No. 12-‐‑3474
ies failed. Both subsidiaries were banks (Irwin Union Bank &
Trust and Irwin Union Bank, FSB), which the Federal Depos-‐‑
it Insurance Corp. closed and took over in 2009. The banks’
asset portfolios had been dominated by mortgage loans,
whose value plunged in 2007 and 2008. The FDIC is in the
process of collecting the banks’ assets and paying their
debts. Further details are not material to the disposition of
this appeal.
Elliott Levin, Irwin Financial’s trustee in bankruptcy,
filed this suit against three of its directors and officers. For
simplicity, we refer to Irwin Financial and the trustee collec-‐‑
tively as “Irwin,” to Irwin’s two subsidiaries as “the Banks,”
and to the defendants as “the Managers.” The FDIC inter-‐‑
vened to defend its own interests, because whatever Irwin
collects from the Managers will be unavailable to satisfy any
claims that the FDIC has against them. Both the FDIC and
the Managers contend that most of Irwin’s claims belong to
the FDIC under 12 U.S.C. §1821(d)(2)(A)(i), which says that
when taking over a bank the FDIC acquires “all rights, titles,
powers, and privileges of the insured depository institution,
and of any stockholder, member, accountholder, depositor,
officer, or director of such institution with respect to the in-‐‑
stitution and the assets of the institution”. Irwin, the FDIC,
and the Managers all understand this language to allocate to
the FDIC not only the closed banks’ rights but also any
claims that investors might assert derivatively on behalf of
the closed banks. Courts of appeals (including this one) rou-‐‑
tinely describe §1821(d)(2)(A)(i) the same way. See, e.g., Ada-‐‑
to v. Kagan, 599 F.2d 1111, 1117 (2d Cir. 1979); Courtney v.
Halleran, 485 F.3d 942, 950 (7th Cir. 2007); Pareto v. FDIC, 139
F.3d 696, 700 (9th Cir. 1998).
No. 12-‐‑3474 3
Irwin presented four types of claims against the Manag-‐‑
ers. The first (counts 1, 2, 4, and 5 of the complaint) asserts
that the Managers violated their fiduciary duties to Irwin by
not implementing additional financial controls that would
have protected Irwin from the Managers’ errors in their roles
as directors and managers of the Banks. The Managers (as
officers of the Banks) allowed the Banks to specialize in
kinds of mortgages that were especially hard-‐‑hit in 2007 and
2008. Irwin contends that they should have diversified the
Banks’ portfolios, hedged the risk using other instruments,
or both, and are liable to Irwin for failing to implement hold-‐‑
ing-‐‑company-‐‑level rules that would have compelled them to
curtail bank-‐‑level risks.
Count 3 alleges that the Managers allowed Irwin to pay
dividends (or, equivalently, repurchase stock) in amounts
that left it short of capital when the financial crunch arrived.
Irwin maintains that it would not have distributed money to
investors had the Managers furnished better information
about the Banks’ portfolios, for then Irwin would have real-‐‑
ized the benefit of being better capitalized.
Count 6 alleges that one of the Managers breached his
duty of care by hiring unnecessary (or unnecessarily expen-‐‑
sive) consultants, squandering Irwin’s money. Irwin’s reply
brief abandons this claim; we do not mention it again.
Count 7 alleges that two of the Managers breached their
duties of care and loyalty when in the first half of 2009 they
“capitulated” to the FDIC and caused Irwin to contribute
millions of dollars in new capital to the Banks. The com-‐‑
plaint asserts that the Managers knew, or should have
known, that this was equivalent to throwing money away—
that it might benefit the FDIC (and could conceivably benefit
4 No. 12-‐‑3474
the Managers in their roles at the Banks) but held no pro-‐‑
spect of benefit for Irwin.
The district court asked Magistrate Judge Baker for anal-‐‑
ysis. He recommended that the first cluster of counts (1, 2, 4,
and 5) be dismissed because under §1821(d)(2)(A)(i) the
FDIC rather than Irwin owns any legal claim that depends
on acts the Managers took in their roles at the Banks. He rec-‐‑
ommended that counts 3 and 7 continue to summary judg-‐‑
ment or trial. The district judge, however, concluded that all
claims belong to the FDIC, and she dismissed the entire
complaint. Irwin has appealed. The Managers defend the
district court’s decision; the FDIC does not and concedes
that counts 3 and 7 belong to Irwin. (The FDIC nonetheless
asks us to affirm across the board, contending that Irwin’s
position on these counts is substantively implausible.)
All of the litigants agree that the distinction between di-‐‑
rect and derivative claims depends on Indiana law, for Irwin
was incorporated there. Indiana treats a stockholder’s claim
as derivative if the corporation itself is the loser and the in-‐‑
vestor is worse off because the value of the firm’s stock de-‐‑
clines. See Barth v. Barth, 659 N.E.2d 559 (Ind. 1995); Massey
v. Merrill Lynch & Co., 464 F.3d 642, 645 (7th Cir. 2006) (Indi-‐‑
ana law). That’s a good description of the theory behind
counts 1, 2, 4, and 5: The Banks suffered a loss when the val-‐‑
ue of their portfolios cratered, and Irwin suffered a deriva-‐‑
tive loss when the value of its stock in the Banks plummeted.
At oral argument counsel for Irwin conceded that it would
not have suffered any injury unless the Banks had done so
first. The theory behind these counts—that the Managers
owed a duty to Irwin to protect it from their own behavior at
the Banks—is a veneer over a derivative claim based on the
No. 12-‐‑3474 5
harm the Managers’ choices caused to the Banks and trans-‐‑
mitted to Irwin through a decline in the value of the shares it
held. The FDIC, not Irwin, therefore owns any claim against
the Managers that depends on the choices they made as di-‐‑
rectors or employees of the Banks. Any recovery by Irwin
would be double counting. See Mid-‐‑State Fertilizer Co. v. Ex-‐‑
change National Bank, 877 F.2d 1333, 1335–36 (7th Cir. 1989);
Kagan v. Edison Bros. Stores, Inc., 907 F.2d 690 (7th Cir. 1990).
Count 3, by contrast, concerns only what the Managers
did at Irwin—both with respect to supporting the financial
distributions and with respect to the information they gave
Irwin about the Banks’ loan portfolios. If count 3 is dis-‐‑
missed, the FDIC cannot gain; it owns the Banks and all of
their assets, but the Banks cannot collect from the Managers
for any shortcomings in the services that they rendered to
Irwin. Section 1821(d)(2)(A)(i) is designed to allocate claims
between the FDIC and other injured parties; it is not de-‐‑
signed to vaporize claims that otherwise exist after a busi-‐‑
ness failure. Yet if count 3 is dismissed, the claim will disap-‐‑
pear; no one will be able to pursue it. It would not be sensi-‐‑
ble to read §1821(d)(2)(A)(i) that way.
The potential problem with count 3 is not ownership but
whether Indiana law permits recovery on a theory that a
holding company distributed “too much” to its investors. As
a first approximation, dividends and repurchases are a
wash; stockholders gain exactly what the corporation loses.
These transactions leave the firm with less capital, but this
may be beneficial if it induces managers to work harder and
smarter. And if the firm later lands in financial trouble,
stockholders see payouts as a blessing—for the distribution
means that the money was not lost with the firm’s financial
6 No. 12-‐‑3474
distress. But the district court did not dismiss count 3 on the
merits, which have not been fully briefed on appeal. Nor
have the parties explored how Indiana’s version of the Busi-‐‑
ness Judgment Rule applies to the Managers’ activities with
respect to information and distributions. It was accordingly
premature to dismiss this part of the complaint.
The district court thought that count 3 does not narrate a
“plausible” claim, as the Supreme Court used that word in
Ashcroft v. Iqbal, 556 U.S. 662 (2009), and Bell Atlantic Corp. v.
Twombly, 550 U.S. 544 (2007). Yet those decisions concern the
adequacy of the notice given by the pleading, not the claim’s
legal substance. The Court held that Fed. R. Civ. P. 8 is not
satisfied by a skeletal complaint that contains conclusion or
surmise and requires a court to decide whether events not
pleaded could be imagined in a plaintiff’s favor. The Court
wrote that judges may bypass implausible allegations and
insist that complaints contain enough detail to allow courts
to separate fantasy from claims worth litigating. Iqbal and
Twombly do not change the standards for judgment on the
pleadings (Rule 12(c)) or summary judgment (Rule 56), nor
do they require complaints to address potential defenses
such as the Business Judgment Rule. The Court held in
Gomez v. Toledo, 446 U.S. 635 (1980), that complaints need not
anticipate affirmative defenses; neither Iqbal nor Twombly
suggests otherwise. See Richards v. Mitcheff, 696 F.3d 635 (7th
Cir. 2012). So although count 3 may not have much prospect,
it could not be dismissed at the suit’s outset.
Count 7 maintains that two of the Managers injured Ir-‐‑
win by causing it to invest more money in the Banks even
after they had failed. Fundamentally it alleges that they
threw good money after bad. Again this is based on injury
No. 12-‐‑3474 7
that Irwin sustained in its own right, a claim that the FDIC
could not pursue as the Banks’ successor. (Counsel for the
FDIC agreed with this proposition at oral argument.) Irwin’s
loss does not depend on injury to the Banks; to the contrary,
Irwin’s investment would have made the Banks better off.
But since they were under water (so the complaint alleges) at
the time of the investment, Irwin suffered an immediate and
irreparable loss. This is the strongest of Irwin’s claims be-‐‑
cause it potentially entails a violation of the duty of loyalty;
Irwin contends that the two Managers sought to promote
their own interests (as officers of the Banks) at the expense of
Irwin’s interests. Count 7 cannot be dismissed under
§1821(d)(2)(A)(i) or Rule 8.
At oral argument the court asked counsel whether
§1821(d)(2)(A)(i) should be understood not simply to allo-‐‑
cate claims between the FDIC and other entities, but to trans-‐‑
fer to the FDIC all claims held by any stockholder of a failed
bank—even claims that like counts 3 and 7 do not depend on
an injury to the failed bank. No federal court has read the
statute that way, however, and counsel for all of the litigants
declined to adopt that understanding. Section
1821(d)(2)(A)(i) transfers to the FDIC only stockholders’
claims “with respect to … the assets of the institution”—in
other words, those that investors (but for §1821(d)(2)(A)(i))
would pursue derivatively on behalf of the failed bank. This
is why we have read §1821(d)(2)(A)(i) as allocating claims
between the FDIC and the failed bank’s shareholders rather
than transferring to the FDIC every investor’s claims of eve-‐‑
ry description. Any other reading of §1821(d)(2)(A)(i) would
pose the question whether Irwin and similarly situated
stockholders would be entitled to compensation for a taking;
8 No. 12-‐‑3474
our reading of the statute (which is also the FDIC’s) avoids
the need to tackle that question.
The judgment of the district court is affirmed with re-‐‑
spect to counts 1, 2, 4, and 5. It is vacated with respect to
counts 3 and 7. The case is remanded for further proceedings
consistent with this opinion.
No. 12-3474 9
HAMILTON, Circuit Judge. I join Judge Easterbrook’s opin-
ion for the court. His opinion accurately applies the differ-
ence between a shareholder’s direct and derivative claims,
which all parties agree is the decisive legal question. Counts
three and seven are correctly categorized as direct claims
and must be remanded, even though they do not have prom-
ising futures because of the Business Judgment Rule.
I have come to that conclusion reluctantly, however.
Stepping back from the parties’ arguments, I believe this case
raises some broader policy questions that deserve considera-
tion by the FDIC and Congress, including why the di-
rect/derivative distinction should still matter, either under
the current version of the Financial Institutions Reform, Re-
covery, and Enforcement Act of 1989, see 12 U.S.C.
§ 1821(d)(2)(A), or perhaps other statutory amendments that
Congress may want to consider.
The most interesting facts about this case are buried in
two footnotes in the briefs. They concern money that might
be available to pay the plaintiff in this case, the trustee of Ir-
win Financial Corporation, which is the holding company
that presided over this expensive debacle. The money could
come from Irwin Financial’s director and officer liability in-
surance policy.
That insurance policy covered directors and officers of
Irwin Financial and all of its subsidiaries, including the de-
funct banks that were taken over by the FDIC. It is apparent-
ly a “wasting” policy, meaning that the legal costs of defense
are charged against the policy limits and thus reduce the
amount available to compensate the FDIC for its expendi-
tures in excess of $500 million to clean up the mess. See
FDIC Br. at 16 n.10; IFC Reply Br. at 19 n.17. And that mess,
10 No. 12-3474
we need to remember, was left behind by the entire Irwin
Financial empire and its directors and officers.
To the extent those insurance proceeds might be used to
pay Irwin Financial, the result is troubling. It is even more
troubling because two of the three directors and officers
whose actions are targeted in this case and who are covered
by the insurance policy held positions with both the holding
company (Irwin Financial) and its defunct banks. Under
those circumstances, allowing Irwin Financial any prospect
of recovery ahead of or on par with the FDIC turns the equi-
ties upside down. Yet that result follows from the parties’
and our adoption of the direct/derivative dichotomy in in-
terpreting 12 U.S.C. § 1821(d)(2)(A), which gives the FDIC
extensive rights with respect to failed banks. 1
One possible solution to the problem I see would be a
broader reading of § 1821(d)(2)(A) than the parties have em-
braced. Section 1821(d)(2)(A) provides that when the FDIC
steps in as the conservator or receiver of a failed bank, it
shall succeed by operation of law to “all rights, titles, pow-
ers, and privileges of the insured depository institution, and
of any stockholder, member, accountholder, depositor, officer,
or director of such institution with respect to the institution and
the assets of the institution.”
1 I recognize that, as a practical matter, the trustee at this point repre-
sents the interests of Irwin Financial’s creditors rather than its share-
holders. I doubt that those creditors participated in Irwin Financial’s
profits or the financial debacle that required the FDIC to step in. Nothing
about the trustee’s claims, however, depends on Irwin Financial itself
having gone into bankruptcy. If Irwin Financial had managed to remain
solvent itself, it would be able to assert counts three and seven as direct
claims for the benefit of its own shareholders.
No. 12-3474 11
The parties, including the FDIC itself, and Judge Easter-
brook’s opinion interpret this language about the rights of a
stockholder to be limited to derivative claims a stockholder
might have. It is not obvious to me that the language must
be interpreted so narrowly, nor did the cases cited at page 2
of the opinion confront this issue or require that result. The
FDIC can already pursue what would be a derivative claim
because the claim really belongs to the failed depository in-
stitution itself. So what does the language referring to “the
rights … of any stockholder” add to the meaning and effect
of the statute? The doctrine that statutes should not be con-
strued to render language mere surplusage is not absolute,
but it weighs in favor of a broader reach that could include
direct claims. See, e.g., Dunn v. Commodity Futures Trading
Comm’n,

519 U.S. 465

, 472 (1997). If “rights … of any stock-
holder” was meant to refer only to derivative claims, it’s a
broad and roundabout way of expressing that narrower
idea.
The statutory language is not precise and could be inter-
preted, for sound policy reasons, more broadly to include a
stockholder’s direct claims that are based on harms resulting
from dealings with the assets of the failed institution, or at
least claims against other persons and entities who were part
of the holding company structure. Under that broader read-
ing, it would be possible for the FDIC to go after all the in-
surance proceeds and other available assets in a case like this
one, at least until the FDIC has been fully reimbursed for the
losses it incurred to protect depositors from the folly of the
banks and their parent company, plaintiff Irwin Financial.
At the core of the financial crisis of 2008 were policies
that allowed bankers and other financiers to “privatize prof-
12                                                      No. 12-3474
its” but “socialize losses.” See, e.g., Joseph E. Stiglitz, Freefall:
America, Free Markets, and the Sinking of the World Economy
(2010). There are of course powerful reasons for the FDIC
and its counterparts for credit unions and other financial in-
stitutions to play their vital roles in socializing losses to pro-
tect depositors and stabilize the economy. Any student of the
Great Depression who remembers the “runs” on banks can
appreciate those roles. But this case at its core presents a
troubling effort. The holding company structure and the di-
rect/derivative dichotomy are being used in ways that could
allow those who ran the banks into the ground to take for
themselves some of the modest sums available to reimburse
the FDIC for a portion of the socialized losses they inflicted.
If that result is not contrary to federal law, it should be. I
do not know whether the stakes on a national level are large
enough to motivate policymakers to act, but there are several
ways to accomplish that more just result. First, the FDIC
could choose to modify its interpretation of the ambiguous
§ 1821(d)(2)(A). That course would depend on having courts
accept that new interpretation. Even better, Congress could
amend the statute to clarify that it does not want to let those
responsible for these financial debacles push ahead of the
FDIC in collecting available assets. A statutory rule giving
the FDIC priority over such “direct” claims by stockholders
of failed banks against others within the holding company
structure would surely withstand any challenge by parties
like Irwin Financial under the Takings Clause of the Fifth
Amendment. And no doubt there are other ways that ex-
perts in this field could devise to protect the public interest.
Counsel for Irwin Financial’s trustee pointed out in oral
argument that the FDIC is supported by insurance premi-
No. 12-3474                                                13
ums collected by covered banks rather than by direct appro-
priations by Congress. The FDIC asserts, however, that its
insurance is backed by the full faith and credit of the United
States government, meaning all taxpayers. In light of that
public interest and the banks’ ability to socialize the losses
they cause, I hope the FDIC and/or the Congress will consid-
er this issue.